The Real Deal New York

An existential fight: Lawsuit questions how closely air rights are tethered to land

By Kathryn Brenzel | October 09, 2017 08:30AM

“The Scream” and 200 East 39th Street (credit: Edvard Munch and CityRealty)

Despite their very real impact, air rights are one of the most abstract concepts in development. Now a developer and lender are clashing over how tightly these rights are tied to the properties they spring from, and the fight’s outcome could have far-reaching implications.

The issue is at the heart of a lawsuit filed by CB Developers against one of their lenders, Texas-based LStar Capital Finance. CB’s mortgage from LStar states that collateral includes development rights acquired by the developer in “connection with the land and the development with the land.” CB argues that the rights are divorced from the land, while LStar claims they are inseparable.

CB, which developed a mixed-use building at 200 East 39th Street, received 50,810 square feet of air rights from the city through its inclusionary housing program. The developer received the rights because it included 19 affordable housing units in its project.

CB used 9,475 square feet of the density bonus on the project, the maximum allowed on the site. This left 25,358 square feet of air rights that needed to be either sold or transferred. The developer tried to sell a portion of the rights, 3,948 square feet, but LStar, which provided $48.3 million to CB in 2016 to refinance the project, objected. The lender claimed the rights were part of collateral on the financing.

In its complaint, CB argues that the air rights shouldn’t count as collateral on its mortgage since it has to be transferred to another site in order to be valuable. CB argued that the rights don’t count as “real property” because they can’t be “liened through a mortgage or taxed.”

In its motion to dismiss CB’s lawsuit, LStar countered that development rights have been “widely recognized as attaching to the land since the early 14th Century.” The lender also argued that their contract very clearly included development rights in its definition of collateral.

“Though the development rights at issue here are termed ‘bonus’ rights,’ and though they allegedly may not be used on the property in its current state, the fact remains that they derive from an underlying common-law right to build upon the land,” attorneys for LStar wrote in the motion.

The state Supreme Court in Manhattan tossed LStar’s motion, and the lender appealed. An appellate court ruled this week that the case can continue, finding that CB’s argument that the air rights aren’t an “inherent element of ownership of the land” is a valid one.

The decision of this case, which now heads back to the lower court, could have a ripple effect in terms of how air rights are treated in relation to financing. The lawsuit could set a precedent for how closely air rights are bound to the associated land and could determine if inclusionary air rights are in a league of their own. At the minimum, though, the case could put developers and lenders on a higher alert when crafting mortgage documents.

“It means developers and lenders should take a closer look at “boilerplate” mortgage language when negotiating their rights,” Kevin Ainsworth, an attorney for CB, told The Real Deal.

He referred to the air rights as floor area compensation rights, saying that the terms “air rights” and “development rights” don’t neatly describe density bonuses created through the city’s inclusionary housing program. Such density bonuses are created, essentially, out of thin air — unlike other air rights that spring from unused floor area ratio (FAR) on the property.

Brian Strout, of City Center Real Estate, noted that unlike other property interest transfers, off-site inclusionary housing rights are not publicly recorded. He said if the mortgage doesn’t have a specific provision covering inclusionary rights, the developer has a strong argument.

An attorney for LStar was not immediately available for comment.